The glaring problem with oil giants' production freeze

NEW YORK (Bloomberg) -- Oil traders aren't too impressed with Saudi Arabia and Russia's accord to cap oil production at near-record levels.

 

After rising above $31.50/bbl when news of this agreement was reached, front-month West Texas Intermediate futures contracts have since retreated to below $30/bbl.

 

It's not just the production freeze, rather than an outright cut, that helps explain the minimal impact this announcement has had on prices, or the conditions attached to it. What also doesn't help buoy prices is the fact that for the two largest oil-producing nations, there's been a de facto ceiling at these levels for an extended period of time.

 

Over the past four years, there has been very little change in Russian or Saudi crude output—especially compared to other major oil-producing nations.

 

During this span, Libyan and Iranian oil production have plunged, North American output skyrocketed thanks to the shale revolution, and Iraqi production has ratcheted up. Production growth (or a lack thereof) in these nations, not Russia or Saudi Arabia, will play the driving role in determining when prices recover, and to what level. Saudi Arabia has spare capacity to boost output further; Russia, for its part, will be challenged to maintain production at these elevated levels in light of the decline rates in its Siberian fields.

 

A review of the resolution to the stretch of low oil prices in the late 1990s suggests that if history repeats itself, progress on bringing the market back into balance from the supply side will be an incremental and prolonged affair requiring cooperation between OPEC and non-OPEC producers. 

 

"There are big countries missing here, obviously Iran is not part of this deal, and the other big country that is missing on this new cartel, if we call it that way, is Texas, North Dakota, and Oklahoma," said Bloomberg Chief Energy Correspondent Javier Blas. "We need the U.S. oil men to join. If they don't join, we are not going to have the kind of muscle that you need to influence the market."